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U.S. POLITICS

Let’s Drive a Stake Through the Heart of Stakeholder Capitalism.

Adding ideology to the stakeholder mix will prove costly and dangerous in the long term.

There are many compelling arguments why the profit motive for companies typically aligns with other laudable objectives relevant to their “stakeholders,” which is often understood as a company’s shareholders, but also includes customers, employees, vendors, the communities in which a company operates, and can even include society and the economy as a whole. Failing to consider the interests of these stakeholders can quickly become costly. For example, underpaying employees motivates them to leave, often incurring significant costs in retraining and a loss of institutional and technical knowledge. Excessively squeezing the profits of vendors can result in their refusal to supply or cutting corners and quality. Poor quality or overpriced goods or services will drive customers away.

[I]t is a zero-sum game, with winners and losers all competing for the same fixed amount of resources…

A relatively recent movement championed by Sen. Elizabeth Warren (D-MA) dubbed “Stakeholder Capitalism” aims to redistribute profit from shareholders—the owners of the business—to the other stakeholders, although most of her rhetoric seems directed at enhancing the fortunes of employees. In 2019, Warren updated her proposed “Accountable Capitalism Act” to obligate companies with more than $1 billion in annual revenue to “consider the interests of all corporate stakeholders—including employees, customers, shareholders, and the communities where the company operates.” There are no obvious objective guidelines for accomplishing this, and it is a zero-sum game, with winners and losers all competing for the same fixed amount of resources: employees want higher wages; customers, lower prices; and shareholders, higher return on investment—all of which are unlikely to occur simultaneously.  Sen. Warren’s bill sheds no light on how to reconcile these competing interests.

But the damage does not end there.

The fundamental principle of a capitalist system is that it “discovers” a price at which there is a willing seller and a willing buyer. This also applies to the use of investment capital. Profit is only possible when costs, which are determined by market forces, allow goods or services to be produced for less than their market value to customers, and when the return on capital (that is, profit) required to do so meets the objectives of shareholders. The economic “law” of supply and demand that underpins this process cannot be repealed by government action, any more than Congress can legislate that the constant π (Pi), the ratio of the circumference to the diameter of a circle, be exactly 3.0. (It’s actually 3.14159…)

The consequences of attempting to circumvent the power of capitalism by fiat are exemplified by the empty supermarket shelves and shoddy goods in the old Soviet Union with its “central planners.” Their system, in which market forces played virtually no role in commerce, demonstrated that artificial interventions create an imbalance of supply and demand, with destabilizing consequences on both sides. That operated to the detriment of all the “stakeholders”: We recall a quip from workmen in the Soviet Union, “We pretend to work, and they pretend to pay us.

Sen. Warren’s Stakeholder Capitalism, which is intended to outwit market forces, is a similar artifice. In 2018, she proposed the original Accountable Capitalism Act, which was intended to partially implement her vision for larger companies by requiring 40% of directors to be elected by employees, as well as the introduction of a federal corporate charter. The election stipulation would have created an inherent conflict of interest for the new directors because the board’s fiduciary duty is to shareholders, which is a fundamental tenet of corporate governance. Moreover, the charter would have added the potential for further exposing directors to liability and shareholders to arbitrary confiscation of profits for political purposes.

Even seemingly modest changes would have had far-reaching consequences, which is not atypical of government intervention in the private sector when it is driven by ideological politicians with little concern for the real world.

Stock market monitors.

Stock market monitors.

GRUDGEHOLDER CAPITALISM

Today, whether it is labeled as such or not, a new malign form of Stakeholder Capitalism is emerging, to our detriment. The newly enfranchised “stakeholders” entering the picture are politicians and ideologues motivated by factors external to business, and who are often oblivious to the interests of the core stakeholders in a corporation, especially the shareholders. The news these days is replete with accounts of companies making politically driven decisions about their employees, vendors, customers, and home communities to please (or, more aptly, to pander to) its new class of imperiously imposed stakeholders. Because satisfying them entails exclusionary practices, we have dubbed this new framework “Grudgeholder Capitalism.”

[P]olitical polarization of business can disenfranchise stakeholders and prevent their access to vital products, services, or employment, solely because of their ideas…

If allowed to continue, this move toward Grudgehold Capitalism would devolve our economic system into a fragmented business universe. We’d have progressive companies and conservative companies, each focusing on different stakeholders whose views politically align with their own—similar to the way cable news networks target different populations of viewers. We could end up with pharmacies like Rite Aid and Left Aid, and companies making “conservative pillows” and “progressive pillows.” We already have Twitter and Parler. (Oops—bad example, given that the latter has just been “canceled.”)

That somewhat dystopian scenario exposes the evil of adding ideology to the stakeholder mix. Business disputes stemming from the consequences of a free market can inflame passions and even ignite unrest (and occasional violence), exemplified by militant strikers, picketing, or company boycotts. But participants in the free market are usually able to work out their differences. By contrast, the political polarization of business can disenfranchise stakeholders and prevent their access to vital products, services, or employment, solely because of their ideas, non-commercial speech, or actions unrelated to their business relationships. This is “canceling” writ large, and is rarely amenable to negotiation.

We already have a glimpse at how the influence of politics can undermine the long-term interests of companies. The Communist Chinese Party (CCP) has exerted corporate control in China and demanded censorship (including sometimes outside of China), usurped intellectual property for the benefit of domestic competitors, and controls access to its domestic markets. In essence, the CCP has preempted the role of directors in determining key business practices that directly affect shareholders, including, but not limited to, how to manage key corporate assets (e.g., intellectual property), and dilution of ownership (by requiring domestic partners). This can have severe long-term impacts on the profits of a company. In effect, the CCP operates by blackmailing companies and holding access to their markets hostage.

True, Grudgeholder Capitalism in the U.S. context may function in a slightly less heavy-handed manner because domestic markets are difficult to hold hostage. But, the potential consequences may have similar long-term negative impacts if the insertion of politics limits market access, artificially increases costs and thus diminishes profits, or restricts the pool of potential employees or suppliers.

Potential victims include employees, vendors, customers, and even communities.

Under this framework, profit ceases to be the defining principle of commerce. Succumbing to political pressure, companies’ management can sacrifice profits (the shareholders’ “stake”) to expel or marginalize other disfavored stakeholders. Potential victims include employees, vendors, customers, and even communities. In theory, directors elected by shareholders should bar management from this practice, but if politics transcends business, the directors’ fear of being fired, canceled, and exiled will deter proper board oversight.

For a time, this sacrifice of profit may not be significant enough to halt Grudgeholder Capitalism. But it is far from clear that this will persist. Twitter, Apple, Google, and Amazon may be powerful enough to have digitally guillotined Parler without consequence (though the repercussions are only starting), but political polarization and pandering will take their toll. There are many millions of Americans who will eventually flock to companies that condemn and refuse to adopt a distorted economic system.

Wall Street Bull.

Wall Street Bull.

UNDERMINING THE BASIC PRINCIPLES OF ECONOMICS AND COMMERCE

Effective governance of a free-market society requires aggressive steps to rein in this corruption of the economic system that has built America and made it prosperous. Claims that the new trends somehow promote “equality” or other intangible social benefits are unproven, at best; fatuous, at worst. Grudgeholder Capitalism promises far more victims than beneficiaries.

The real issue is power—power over decisions made in the private sector.

The real issue is power—power over decisions made in the private sector. Perhaps that was Sen. Warren’s goal in her push for Stakeholder Capitalism. Even if not, she must be delighted at the prospect of undermining the basic principles of economics and commerce while opening new opportunities for government control and intervention. She has many accomplices, of course, but the number of victims damaged by Grudgeholder Capitalism and those who see its downside will grow with every cynical political intervention into the system.

There is a compelling case to be made that business should be as apolitical as possible to fulfill its telos. That is a corollary of 18th-century economist and philosopher Adam Smith’s metaphor of “the invisible hand”—that through individual self-interest and freedom of production and consumption, the best interests of society, as a whole, are fulfilled, and that, in the aggregate, individual decisions about market supply and demand enable the natural movement of prices and the flow of trade.

Government intervention into capitalism should be limited and reserved primarily to address specific abuses. This philosophy has worked for much of American history and for most western economies. It brings to mind the adage “Do No Evil,” which was long a fixture of Google’s official code of conduct—one that was discarded in 2018. How times change…

Andrew I. Fillat spent his career in technology venture capital and information technology companies. He is also the co-inventor of relational databases. They were undergraduates together at M.I.T. Henry I. Miller, a physician and molecular biologist, is a Senior Fellow at the Pacific Research Institute. He was the founding director of the Office of Biotechnology at the FDA.

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